Housing Market Effect on Wealth

Property has long been seen as one of the most stable and profitable assets. While most of us pinch our pennies and place a percentage of our income into savings, it is the housing market that is widely regarded as the most sure-fire path to lifelong wealth.

And while it is certainly true that the housing market is less volatile than shares or stocks, and a large number of owners have seen skyrocketing profit during the most recent spike in the market, wealth from property is by no means a guarantee.

For first home buyers and young families, it’s important to understand that our entire borrowing system relies on the assumption that value will rise. After all, that’s why we’re happy to pay interest on our loan. But when the market hits a standstill, or worse, falls, then inexperienced buyers can find themselves in serious financial strain. It’s crucial to discover this effect on housing that buyers need to know.

Recent Research on Housing Capital Gain

Recent growth phases in the housing market have meant that homes are worth more than ever. We’ve seen the average house price tip over $1 million in Sydney, and Melbourne isn’t far behind. While these markets may be more difficult to enter than ever, those fortunate enough to have owned during the past decade have seen significant wealth accumulation.

In Sydney and Melbourne, the number of homes which are worth more than double what they were purchased for has increased over the past 10 years, from 37.2% up to 48.1%. That means almost half of homeowners have made 100% profit from their investment.

But while these two cities get most of the limelight, it may surprise you to know that these trends aren’t shared across the board. Outside of Sydney and Melbourne, that same statistic has dropped in the past decade, from 45.4% to 39.1%. Regional areas, particularly in WA where the aftermath of the mining boom has seen prices plummet, were worst hit. This region came in at the highest proportion of homes worth 10% less than what they were bought for.

The Wealth Effect

Humans are biased creatures, and so we often exhibit tendencies which might not always be entirely rational. One of these tendencies is the wealth effect, a phenomenon in which we associate rising asset prices with an increased notion of wealth. If our housing market is on the rise, we immediately feel richer, and start spending up on everything from retail goods to stocks and even taking out larger loans. It might make sense that we could expect our home’s value to rise in line with a good market, but until the hammer falls, there is no real evidence of increased wealth. The point is, we get too excited before the money is actually in our pockets.

Without the physical wealth in our bank accounts, we start using our homes as ATMs, borrowing against them, dipping into our newly discovered equity and spending money that we don’t have, all because of this delusion that we are richer than we really are. And there are knock on effects that keep the cycle perpetuating. Our spending activity directly supports employment and increased income.

But we run into trouble when those all-important house values start to plateau. We begin to cut down on spending, repaying the debt that we have found ourselves in. Just as income and employment rose before, now it begins to fall.

Economists call this rise and fall a positive feedback loop. The good times are good, but the bad times are bad. It’s the perfect storm for a cycle of booms and busts. Throughout the 2000s, as asset prices continued to rise, so did spending. When the GFC hit, our own spending-induced debt coupled with the fall in asset prices was enough to ruin people.

Lessons to be Learned

Increased spending during these growth times means less is being put away into savings. For young families, or those owner occupiers who have just bought their first home, beware of the temptations of increasing housing markets. Some of our incomes should always be put away into savings, and now that you’ve landed a house, things are no different. Instead of saving for a deposit, it might be for a holiday, your next deposit, or just a rainy day. Circumstances can change unexpectedly, and now that you have a mortgage to pay off, you should always have a solid chunk of savings behind you, to tide you over for at least six months if something were to happen.

Understanding trends in the market, as well as your own financial situation and spending habits, are just some of the lessons to learn as a first home buyer.